1. ABC firm has determined its optimal capital structure, which is composed of the following sources and target market value proportions:

Source of Capital	Target Market Proportions
Long-term debt	40%
Preferred stock	5
Common stock equity	55

Debt: The firm can sell a 20-year, $1,000 par value, 8 percent bond for $980. A flotation cost of 2 percent of the face value would be required in addition to the discount of $20.

Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $3 per share.

Common Stock: The firms common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year is $5.00 Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.15. It is expected that to sell, a new common stock issue must be underpriced at $1 per share and the firm must pay $1 per share in flotation costs. Additionally, the firms marginal tax rate is 40 percent.

Calculate:

1. Cost of debt

First, we have to calculate the before-tax cost of debt.

So,

Par value = $1,000

Annual interest = 80

Net proceeds from the sale of debt (bond) = ($980 - $20) = 960

Number of years is 20

PV = 960

PMT = -80

FV = -1,000

N = 20

Before tax cost of debt is 8.420%

The after-tax cost of debt can be found by following equation: r_i = r_d (1 T)

Where r_i = after-tax cost of debt, r_d= before-tax cost of debt, and T= tax rate.

8.420% x (1 0.40%) = 5.052%

2. Cost of preferred Stock

Using the following formula to found the cost of preferred stock:

r_{p =} D_pN_p

where r_p= cost of preferred stock, D_p = the stock dividend, and N_p = the net proceed

r_{p =} $8.00$75-$3

r_{p = $8.00}$72 = 11.1%

The cost of ABC preferred stock is 11.1%

3. Cost of Common Stock Equity

First, we have to calculate the growth rate of common stock by using the financial calculator which are

N = 5,

PV = $3.15, and

FV = $5.00

So, the growth rate of common stock is 9.861%

Second, we found the cost of common stock equity by using following formula:

r_s = D1P0 + g

where:

D₁ = per share dividend at the end of coming year which is 5.

P₀ = the value of common stock which is ( current stock price underpricing amount flotation costs) = ($50 - $1 - $1) =

4. Calculate the firms weighted average cost of capital assuming the firm has exhausted all retained earnings.